STANDARDS IN ECONOMICS

STANDARDS IN PERSONAL FINANCE

OPTIONS

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The students learn what GDP is. They will learn different measures of GDP as well as how GDP per capita can be used to compare countries. They will also calculate GDP per capita and learn how poorer countries can converge, or close the gap, with richer countries.

KEY CONCEPTS

STUDENTS WILL

Define GDP and GDP per capita and understand how both measures are used to compare countries.

Calculate GDP per capita and how many years it takes for an economy's output to double.

Understand how convergence or closing the gap in GDP between countries can occur, and the benefits of convergence.

INTRODUCTION

Gross Domestic Product, or GDP, is defined as the total market value of all goods and services produced within an economy in a given year. Nominal GDP is GDP based on prevailing prices. GDP is also used as a measure of a country's standard of living. A standard of living is indicated by the necessities, comforts and luxuries enjoyed by an individual or group. Real GDP (Purchasing Power Parity or PPP-adjusted) adjusts for inflation. GDP controls for any year-to-year growth in the GDP due solely to changes in the average price level. GDP per capita, which adjusts both for inflation and the population of the country, is a commonly used figure that allows for comparisons of countries based on their standards of living. It is a good idea to have the students do Focus on Economic Data: Consumer Price Index and Inflation before completing this lesson.

Have the students compare Luxemburg's Real GDP per capita to the United States
.

Luxemburg = $58,198
United States = $40,100

Proceed by having the class discuss why Luxemburg has a higher Real GDP per capita. Answers should refer to Luxemburg's smaller population. The students should understand that GDP per capita will vary widely and that developing countries typically have much lower GDP per capita figures than developed countries.

Real GDP per capita is the measure most used to compare countries based on their economic performance. It is calculated by dividing Real GDP by the population of the country. Luxembourg had a population of 468,571 and a GDP of 27.27 billion in 2004. Its GDP per capita was $27,270,000,000 / 468,571 or $58,198. This compares to the U.S. Real GDP per capita of $40,100 in 2004.

Note: Qatar is a small country in the Middle East with large oil reserves, which accounts for a substantial part of its GDP.

The countries with the lower GDP per capita numbers would normally be classified as developing countries. A country such as Pakistan has a large population and does not have the capital resources of developed countries such as Belgium. The Czech Republic is still emerging from its days as a member of the Soviet Union and has not fully developed as a free market economy.

The next exercise is to compare Canada
and Mexico
. Adk the students which country has the highest GDP per capita. (Canada had a GDP per capita of $31,500 while Mexico's GDP per capita was $9,600 in 2004; most students should be able to figure out that Canada will have the higher GDP per capita due to its developed country status from the preceding discussion about developing and developed countries.)

ASSESSMENT ACTIVITY

The students will use the growth rate in GDP and the Rule of 72 to calculate the expected GDP of Mexico and Canada. They will also see how a higher growth rate could cause convergence between the two countries.

By using the Rule of 72, the students see how long it will take for Canada and Mexico to double their GDPs.

72 / Real GDP growth rate = the number of years for a sum to double

For Canada with a rounded growth rate of 2 percent, it will take 36 years to double their GDP (72/2 = 36). For Mexico with a rounded growth rate of 4 percent, it will only take 18 years (72/4 =18), which means that Mexico will double its GDP twice in 36 years while Canada will only double once. In 36 years, Canada's GDP per capita would be $63,000 (31,500 x 2), while Mexico's GDP per capita would be $38,400 ($9,600 X 2 = 19,200 x 2 = 38,400), so there is still a significant gap between the two countries.

If we assume a 6 percent growth rate for Mexico while Canada stays at 2 percent over a 36-year period, Mexico would see its GDP double three times (72/6 = 12 years and 36 years/12 years = 3) while Canada's GDP would still only double once. Mexico's GDP per capita after 36 years would be $76,800 (9600 x 2 = 19,200 x 2 = 38,400 x 2 = 76,800) while Canada's would still be at $63,000. This would completely eliminate the gap between the two countries and convergence would occur. Growth in GDP can be achieved by greater productivity through more capital resources or more skilled workers.

CONCLUSION

In light of the previous exercise and discussion about developing and developed countries, most students will not be surprised that Canada has a much higher GDP per capita than Mexico. Ask the students why the big difference in GDP per capita exists between Canada and Mexico. (Explanations might include the greater capital resources of Canada, higher education rates and higher skill levels of workers, and greater infrastructure.) Ask the students if the GDP figures support their impression of the standard of living in Canada and Mexico. (Most students would have had an impression that Canadian citizens were, on average, better off than Mexican citizens, and the GDP figures reinforce that impression.)

EXTENSION ACTIVITY

Ask the students to brainstorm how the United States would benefit from Mexico having a GDP per capita closer to the GDP per capita of Canada. Answers might include increased trade with Mexico. Even though Canada is smaller than Mexico in population (population of approximately 32 million), it is the United States's largest trading partner. Mexico has a population of 106 million, and we could expect that Mexico would greatly increase its purchases of U.S. goods if its standard of living were to increase. Another possible answer would be a decrease in the number of illegal immigrants that enter the United States from Mexico. Since many of the Mexican citizens come to the United States for greater economic opportunities, we could assume that there would be fewer illegal immigrants if Mexico had a higher GDP per capita. That would also be a benefit for the United States. Students could look up trade data and immigration figures to support their answers.